<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended September 30, 1997
----------------------------------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from to
------------------ ------------------------
Commission file number 333-26137
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Physicians Quality Care, Inc.
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 04-3267297
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
950 Winter Street, Suite 2410, Waltham, Massachusetts 02154
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (617) 890-5560
-----------------------------
Not Applicable
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(Former Name, Former Address and Former Fiscal Year, if Changed Since Last
Report)
Indicate by check [x] whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days Yes No [x]
--------- ---------
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of issuer's common stock, as of September
30, 1997 was: 7,482,583 shares of Class A Common Stock, $.01 par value,
2,809,296 shares of Class B-1, $.01 par value, 1,790,704 shares of Class B-2
Common Stock, $.01 par value, and 7,692,309 shares of Class C Common Stock, $.01
par value.
<PAGE>
PHYSICIANS QUALITY CARE, INC.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
Part I FINANCIAL INFORMATION
Item 1. Balance Sheets as of December 31, 1996 and
September 30, 1997.................................. 1
Statements of Operations for the nine months
ended September 30, 1996 and 1997................... 3
Statements of Operations for the three
months ended September 30, 1996 and 1997............ 4
Statements of Cash Flows for the nine months
ended September 30, 1996 and 1997................... 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations....... 9
Part II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.................... 14
Signatures .................................................... 15
</TABLE>
<PAGE>
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
Physicians Quality Care, Inc.
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
December 31, September 30,
1996 1997
---------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 136,926 $18,380,715
Prepaid expense 58,776 140,998
Due from related parties 1,694,687 5,856,868
Other current assets 25,380 45,468
---------------------------------------
Total current assets 1,915,769 24,424,049
Long-term affiliation agreements, less accumulated
amortization of $284,643 and $1,204,313 in 1996 and
1997 (unaudited), respectively 32,401,305 33,202,288
Deferred affiliation and equity offering costs 137,831 1,382,486
Property and equipment, net 214,008 1,002,922
Other assets 120,660 255,989
Deferred tax asset 608,171 652,384
---------------------------------------
Total assets $35,397,744 $60,920,118
=======================================
Liabilities and stockholders' equity (deficit)
Current liabilities:
Accounts payable $ 1,217,630 $ 376,340
Accrued compensation 218,893 235,608
Accrued expenses 1,053,892 161,542
Income taxes payable 69,708 (25,192)
Current portion of long term debt 200,000 -
Current portion of capital lease obligations 15,685 -
---------------------------------------
Total current liabilities 2,775,808 748,298
Capital lease obligations, less current maturities 55,867 400,000
Deferred taxes 1,073,048 1,083,048
</TABLE>
See accompanying notes to unaudited financial statements and management's
discussion and analysis
1
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Physicians Quality Care, Inc.
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
December 31, September 30,
1996 1997
---------------------------------------
<S> <C> <C>
Commitments and contingencies
Common stock, subject to put, 12,740,589 and 13,313,082 shares authorized,
issued and outstanding at December 31, 1996
and September 30, 1997, (unaudited), respectively 31,851,473 39,939,247
Stockholders' equity (deficit):
Class A common stock, $.01 par value, 75,000,000 shares authorized,
7,236,033 and 8,495,083 shares issued and 6,223,533 and 7,482,583
outstanding at December 31, 1996
and September 30, 1997, (unaudited), respectively 72,359 84,949
Class B-1, common stock, .01 par value, 15,267,915
shares authorized, 2,442,866 and 2,809,296 shares issued and
outstanding at December 31, 1996 and September 30, 1997,
(unaudited), respectively 24,429 28,093
Class B-2, common stock, .01 par value, 9,732,085
shares authorized, 1,557,134 and 1,790,704 shares issued and
outstanding at December 31, 1996 and September 30, 1997,
(unaudited), respectively 15,571 17,907
Class C, common stock, .01 par value, 13,846,155 shares
authorized, 7,692,309 shares issued and outstanding
at September 30, 1997, (unaudited) - 76,923
Preferred stock, $.01 par value, 10,000 shares authorized - -
Additional paid-in-capital 21,117,623 50,469,972
Accumulated deficit (21,578,309) (31,918,194)
Less treasury stock, at cost, 1,012,500 shares at December 31, 1996 and
September 30, 1997, (unaudited), respectively (10,125) (10,125)
---------------------------------------
Total stockholders' equity (deficit) (358,452) 18,749,525
---------------------------------------
Total liabilities and stockholders' equity $35,397,744 $60,920,118
=======================================
</TABLE>
See accompanying notes to unaudited financial statements and management's
discussion and analysis
2
<PAGE>
Physicians Quality Care, Inc.
Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
For the nine months ended
September 30
--------------------------------------
1996 1997
--------------------------------------
<S> <C> <C>
Net patient service revenue $1,069,767 $31,835,291
Less: amounts retained by physician groups 448,140 10,962,567
--------------------------------------
Management fee revenue 621,627 20,872,724
Operating expenses:
Nonphysician salaries and benefits 295,807 10,036,349
Other practice expenses 215,967 2,172,748
General corporate expenses 3,221,392 10,229,627
Depreciation and amortization 74,286 1,463,371
Provision for bad debts 51,843 835,916
--------------------------------------
Total expenses 3,859,295 24,738,011
--------------------------------------
Operating loss (3,237,668) (3,865,287)
Other income (expense):
Interest income 67,315 311,301
Interest expense (100,735) (129,358)
--------------------------------------
(33,420) 181,943
--------------------------------------
Loss before income taxes (3,271,088) (3,683,344)
Income tax provision 9,400 -
======================================
Net loss ($3,280,488) ($3,683,344)
======================================
Net loss available to common stock ($17,717,336) ($10,339,885)
======================================
Net loss per common share ($1.92) ($0.36)
======================================
Weighted average common shares
outstanding 9,228,584 28,528,490
======================================
</TABLE>
See accompanying notes to unaudited financial statements and management's
discussion and analysis
3
<PAGE>
Physicians Quality Care, Inc.
Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
For the three months ended
September 30
----------------------------------
1996 1997
----------------------------------
<S> <C> <C>
Net patient service revenue $1,069,767 $10,613,635
Less: amounts retained by physician groups 448,140 3,495,121
----------------------------------
Management fee revenue 621,627 7,118,514
Operating expenses:
Nonphysician salaries and benefits 295,807 3,463,602
Other practice expenses 111,787 752,930
General corporate expenses 1,082,706 3,595,060
Depreciation and amortization 57,977 505,010
Provision for bad debts 51,843 280,335
----------------------------------
Total expenses 1,600,120 8,596,937
----------------------------------
Operating loss (978,493) (1,478,423)
Other income (expense):
Interest income 18,931 274,508
Interest expense (7,576) (23,533)
----------------------------------
11,355 250,975
----------------------------------
Loss before income taxes (967,138) (1,227,448)
Income tax provision - -
----------------------------------
Net loss ($967,138) ($1,227,448)
==================================
Net loss available to common stock ($15,403,986) ($1,227,448)
==================================
Net loss per common share ($1.42) ($0.04)
==================================
Weighted average common shares outstanding 10,870,020 34,002,120
==================================
</TABLE>
See accompanying notes to unaudited financial statements and management's
discussion and analysis
4
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PHYSICIANS QUALITY CARE INC.
STATEMENTS OF CASH FLOW
<TABLE>
<CAPTION>
(Unaudited)
For the nine months ended
Sept 30
----------------------------------------
1996 1997
----------------------------------------
<S> <C> <C>
Operating activities
Net loss $ (3,280,488) $ (3,683,344)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 74,286 1,463,371
Interest accretion on convertible promissory note 90,000 -
Changes in operation assets and liabilities, net of effects of business
acquisitions:
Increase in due from related parties (689,933) (4,162,181)
Increase in prepaid expenses and other assets (198,201) (281,852)
Increase (Decrease) in accounts payable, accrued
compensation and accrued expenses 501,988 (1,716,925)
Decrease in income taxes payable (25,792) (84,900)
----------------------------------------
Net cash used in operating activities (3,528,140) (8,465,831)
----------------------------------------
Investing activities
Purchase of property and equipment (149,653) (816,949)
(Increase) decrease in deferred acquisition costs 272,425 (242,754)
Cash paid for affiliation costs (1,241,599) (662,804)
Cash paid for affiliations (2,794,544) (831,231)
----------------------------------------
Net cash used in investing activities (3,913,371) (2,553,738)
----------------------------------------
Financing activities
Proceeds from issuance of common stock, net of
issuance costs 5,094,872 29,447,862
Proceeds from bridge financing 1,000,000 -
Proceeds from note payable and capital lease 85,000 3,900,000
(Increase) decrease in deferred financing costs (73,524) 18,196
Payments on capital lease obligations and note payable (9,694) (3,771,552)
Cash paid for Debt issuance cost - (331,148)
----------------------------------------
Net cash provided by financing activities 6,096,654 29,263,358
----------------------------------------
Net increase (decrease) in cash and cash equivalents (1,344,857) 18,243,789
Cash and cash equivalents at beginning of period 3,479,781 136,926
========================================
Cash and cash equivalents at end of period $ 2,134,924 $ 18,380,715
========================================
</TABLE>
See accompanying notes to unaudited financial statements and management's
discussion and analysis
5
<PAGE>
Physicians Quality Care, Inc.
Notes to Unaudited Financial Statements
Three Months and Nine Months Ended September 30, 1997 and 1996
(1) Basis of Presentation
---------------------
The accompanying unaudited financial statements of Physicians Quality Care,
Inc., a Delaware corporation (the "Company"), have been prepared in accordance
with generally accepted accounting principles and in accordance with Rule 10-01
of Regulation S-X.
In the opinion of management, the unaudited interim financial statements
contained in this report reflect all adjustments, consisting of only normal
recurring accruals which are necessary for a fair presentation of the financial
position as of September 30, 1997 and the results of operations for the three
and nine months ended September 30, 1997 and 1996. The results of operations
for the three and nine month periods ended September 30, 1997 are not
necessarily indicative of results for the full year.
These unaudited financial statements, footnote disclosures and other
information should be read in conjunction with the financial statements and
notes thereto included in the Company Registration Statement on Form S-1, as
amended (No. 333-26137), dated November 12, 1997.
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect the amounts reported in the accompanying financial
statements and notes. Actual results could differ from those estimates.
(2) Net Loss Per Common Share
-------------------------
Net loss per share of common stock is computed by dividing the net loss
available to common stock by the weighted-average number of shares of common and
common equivalent shares outstanding during each period presented. The net loss
available to common stock reflects the accretion of common stock subject to put
to fair value at September 30, 1997 and December 31, 1996. The effect of options
and warrants is not considered as it would be antidilutive. Fully diluted loss
per share is not presented because the effect would be antidilutive.
In February 1997, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings
Per Share", which is required to change the method currently used to compute
earnings per share and to restate all prior periods. Under the new requirements
for calculating primary earnings per share, the dilutive effect of stock options
will be excluded. The impact of SFAS 128 on the calculation of net loss per
common share for the three and nine months ended September 30, 1997 and
September 30, 1996 is not expected to be material.
6
<PAGE>
Physicians Quality Care, Inc.
Notes to Unaudited Financial Statements
Three Months and Nine Months Ended September 30, 1997 and 1996
(3) Affiliations
------------
In January and February 1997, the Company entered into affiliation
arrangements with 6 physicians located in the Springfield, Massachusetts area.
Through mergers and asset purchases, the physician's practices were transferred
to an affiliate of the Company and the physicians became employees of the
affiliate. The aggregate total consideration paid to the physicians or their
practices was approximately $2.3 million, of which $900,000 was paid in cash and
$1.4 million was paid by the issuance of approximately 600,000 shares of the
Company's Class A Common Stock.
(4) Common Stock Issuances
----------------------
In February 1997 and June 1997, the Company issued 472,000 share of Class A
Common Stock for $1,180,000 and 410,400 shares of Class A Common Stock for
$1,026,000, respectively, to stockholders and friends of the Company.
In April 1997, the Company issued 600,000 shares of Class B Common Stock to
its institutional investors for a total consideration of $1,500,000.
In April 1997, the Company issued 80,250 shares of Class A Common Stock in
connection with exercised employee stock options.
On June 20, 1997, the Company issued 7,692,309 shares and warrants to
purchase 7,692,309 shares of Class C Common Stock for a total consideration of
$25,000,000 to its institutional and other investors.
(5) Subsequent Events
-----------------
On October 24, 1997, the Company acquired a 50% interest in two related
physician network management companies in Atlanta, Georgia. The two entities,
TLC Management Company, Inc. and Total Quality Practice Management, Inc., manage
payor contracting for a 350-physician network in Georgia. The network currently
serves approximately 4,500 covered lives, the Company's investment, which totals
$5 million in cash, was used to repurchase the stock of certain existing
shareholders, repay indebtedness, and provide working capital for the growth and
development of the network.
7
<PAGE>
Physicians Quality Care, Inc.
Notes to Unaudited Financial Statements
Three Months and Nine Months Ended September 30, 1997 and 1996
On December 1, 1997, the Company through its affiliate Flagship Health,
P.A., a Maryland professional association ("Flagship"), merged with Clinical
Associates P.A., a Maryland professional association ("Clinical"), pursuant to
which Clinical became affiliated with the Company and subject to a services
agreement between the Company and Flagship. The Company paid the Clinical
stockholders and optionholders an aggregate of $3 million in cash and 4.8
million shares of the Company's Class A Common Stock.
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
This Quarterly Report on Form 10-Q contains forward-looking statements that
involve a number of risks and uncertainties. There are a number of important
factors that could cause the Company's actual results to differ materially from
those indicated by such forward-looking statements. The following discussion
should be read in conjunction with the Company's Unaudited Financial Statements
and Notes thereto included elsewhere in this documents.
OVERVIEW
The Company affiliates with and operates multi-specialty medical practice
groups. The first physician affiliation with Medical Care Partners, P.C., a
Massachusetts professional corporation (the "Springfield Affiliated Group"), was
completed on August 30, 1996 with 32 physicians in the Springfield,
Massachusetts and Enfield, Connecticut area and subsequently the Company has
established affiliations with physicians groups in Baltimore, Maryland (together
with the Springfield Affiliated Group, the "Affiliated Groups") and has acquired
a 50% interest in an independent provider association ("IPA") in Atlanta,
Georgia. As of December 1, 1997, the Company has affiliations or IPA
arrangements with the following physicians:
<TABLE>
<CAPTION>
Affiliated Physicians
---------------------
Maryland Massachusetts Georgia
-------- ------------- -------
<S> <C> <C>
132 41 0
IPA Physicians
--------------
Maryland Massachusetts Georgia
-------- ------------- -------
0 0 350
</TABLE>
The Company is working with these groups of physicians to improve operating
practices and to obtain managed care contracts.
Most of the Company's revenue in 1997 and 1996 was earned under physician
management service agreements. Management fee revenue consists of the net
revenues of the physician practices, less amounts retained by physician groups.
Under the management service agreements, the Company can improve its management
fee revenues by increasing the patient care revenue of its Affiliated Groups,
whether through improved billing and operating efficiency, additional patient
encounters or increase capitated revenues, and controlling the expenses of
Affiliated Groups. To the extent that patient revenue increases at a greater
rate than practice expenses, the Company's management fee revenue will increase.
Conversely, if the Company is not able to control practice expense or assist the
Affiliated Groups in increasing patient care
9
<PAGE>
revenue, the Company will earn no or only a limited management fee.
The Company's and its Affiliated Group's revenues are derived from
governmental programs, managed care payors and traditional fee-for-service
arrangements. The following table sets forth the approximate percentage of
revenues received by the physician practices that were affiliated with the
Company at September 30, 1997 and during the nine month period ended September
30, 1997:
<TABLE>
<S> <C>
Medicare 31.00%
Medicaid 4.00%
Capitated Managed Care 5.00%
Contracts
Fee for Service 55.00%
Other 5.00%
------
100.00%
======
</TABLE>
RESULTS OF OPERATIONS
Nine Months Ended September 30, 1997 and Nine Months Ended September 30, 1996
During the nine months ended September 30, 1996, the Company was primarily
in a development and start up phase. The first affiliation with 32 Springfield,
Massachusetts physicians was completed on August 30, 1996. Prior to this date,
the Company had no revenues. On December 11, 1996, the Company affiliated with
59 physicians in the greater Baltimore-Annapolis, Maryland area. During January
and February 1997, the Company affiliated with six physicians in the
Springfield, Massachusetts area.
The completion of the Springfield and Baltimore affiliations resulted in
the Company having net revenues of approximately $31.8 million for the nine
months ended September 30, 1997 compared to approximately $1.1 million for the
comparable period in 1996. The net revenue for the nine months ended September
30, 1996 represented one month of operations of the initial Springfield
affiliation.
The increase in revenues was more than offset by increases in operating
expenses. The affiliation transactions resulted in the addition of physician
salaries and benefits, non-physician salaries and benefits, other practice
expenses, provision for bad debt, and depreciation and amortization. Prior to
the completion of the first affiliation transaction, the Company incurred
general corporate home office expenses only. During the nine months ended
September 30, 1997 as compared to the nine months ended September 30, 1996, the
amounts retained by physician groups, which represents physician salaries and
benefits, increased approximately $10.5 million;
10
<PAGE>
nonphysician salaries and benefits, which represents salaries and benefits for
staff engaged in the physicians practice, increased approximately $9.7 million;
other practice expenses, which represent primarily occupancy related costs of
physicians practices, increased approximately $1.9 million and provision for bad
debt increased approximately $.8 million. These increases in the physician
affiliation expenses resulted primarily from physician affiliations in December
1996 and in January and February 1997 as well as having nine months of
operations in 1997 for the Company's first physician affiliation as compared to
one month of operations during the nine months ended September 30, 1996.
General corporate expenses consist of non-salary and non-occupancy expenses
of affiliated physician practices, and all costs, except depreciation and
amortization, of the Company's corporate home office and regional operations.
The increase in general corporate expenses of approximately $7 million for the
nine months ended September 30, 1997 as compared to the nine months ended
September 30, 1996 was primarily due to the increase in physician practice
affiliations as well as increases in corporate home office and corporate
regional operations staff to support the Company's growth. During the nine
month period ended September 30, 1996, there was only one month of non-salary
and non-occupancy expenses for the Company's first practice affiliation.
Depreciation and amortization expense consists primarily of amortization of
intangibles associated with affiliated practices. The increase of approximately
$1.4 million for the nine months ended September 30, 1997 as compared to the
nine months ended September 30, 1996 was due to the increase in intangible
assets acquired as practice affiliations were completed. The amortization
expense for the nine months ended September 30, 1996 consists of one month of
amortization on the Company's first practice affiliation.
The increase in interest income of approximately $245,000 for the nine
months ended September 30, 1997 as compared to the nine months ended September
30, 1996 was primarily due to a significant increase in the purchase of the
Company's Class B and Class C Common Stock by institutional investors during the
nine months ended September 30, 1997. Proceeds from the issuance of common
stock, net of issuance costs, were approximately $29.4 million for the nine
months ended September 30, 1997 as compared to approximately $6.1 million for
the comparable period in 1996.
Three Months Ended September 30, 1997 and Three Months Ended September 30, 1996
The three month period ended September 30, 1996 consisted of one month of
operations for the Company's first practice affiliation completed August 30,
1996. The three month period ended September 30, 1997 consisted of a full
quarter operations from the company's first practice affiliation, as well as a
full quarter of operations for an additional 64 physicians practices which were
affiliated with the Company subsequent to September 30, 1996.
The significant increases in all revenue and expense categories and were
primarily due to the same reasons as noted in the above results of operations
for the nine months ended
11
<PAGE>
September 30, 1997 and 1996, namely the significant increase in physician
practice affiliations and the transition of the Company from being almost
exclusively a development phase company from its inception until August 30, 1996
into an operating company.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal requirements for capital are payments to physicians
in connection with affiliation transactions with the Company and its Affiliated
Groups, transaction costs associated with such affiliation transactions, working
capital requirements for its Affiliated Groups and the funding of operating
losses. The Company anticipates that its liquidity and capital resource
requirements will be similar on a long-term and short-term basis. Due to its
start up status, the Company has incurred significant operating losses to date
and does not have operating cash flow to fund growth or further losses. The
Company cannot continue as a going concern without external capital sources.
The Company's principal sources of capital to date have been the issuance of
Class A, Class B and Class C Common Stock, borrowings under a credit agreement
with Bankers Trust Company and cash generated by the operations of the
Affiliated Groups.
During 1996, the Company paid an aggregate consideration of approximately
$29.5 million in connection with affiliation transactions. Of such amount
approximately $5.9 million was paid in cash and approximately $23.6 million was
paid in Class A Common Stock. The majority of such payments were accounted for
as an addition to intangible assets, which represented $32.0 million of the
Company's total assets of $35.0 million at December 31, 1996. During the nine
months ended September 30, 1997, the Company paid aggregate consideration of
$2.3 million in connection with affiliation transactions. Of such amount
approximately $900,000 was paid in cash and approximately $1.4 million was paid
in Class A Common Stock. Of the $2.3 million affiliation consideration,
approximately $2.1 million represents intangible assets. As of September 30,
1997, intangible assets net of amortization costs, represent approximately $33
million of the Company's total assets of approximately $61.0 million. The
Company is amortizing the intangible assets over 25 years.
Subsequent to September 30, 1997, the Company completed an affiliation
agreement with 68 additional physicians in Baltimore, Maryland and has acquired
a 50% interest in two related physician network management companies. The
aggregate consideration for these transactions was approximately $22.4 million
of which $7.0 million was paid in cash, $14.4 million was paid in Class A Common
Stock and $1.0 million is being held in escrow pending the completion of certain
events.
Of the Company common stock outstanding at September 30, 1997, 13,313,082
shares of Class A Common Stock are subject to a put option which provides for
the put of the shares back to the Company at fair value upon the death or
disability of the holder. In addition, 1,072,285 of such shares are also
subject to a fair value put option back to the Company at the later of the
stockholders' retirement from the Company or 18 months after the date (December
11, 1996) of the stockholders' agreement. Consequently, these 13,331,082 shares
of Class A Common Stock
12
<PAGE>
have been recorded at fair value outside of permanent equity in the accompanying
balance sheet. Under the Company's stockholder agreements, the Company may
repurchase up to an aggregate of 10,626,163 shares of Class A Common Stock, for
fair value if the stockholder's termination of employment with the Company is
without cause or is by resignation, and for the lower of cost or fair value if
termination is with cause. The terms of such repurchase provision may not permit
the Company to fully recover its affiliation payments to the physicians or
reflect the cost of affiliation transactions at the time of termination. To
date, no stockholder physician has terminated an employment agreement or
repurchased any practice assets. All of the above put and call provisions expire
on the closing of a public offering of the Company's common stock which results
in net proceeds to the Company of at least $50 million and which meets certain
other criteria. Because the Company's shares are subject to a number of
restrictions in the stockholders' agreements and will not trade until the
occurrence of such an offering, the Company believes it is a nonpublic entity
for compensation accounting purposes and, accordingly, has not recorded any
compensation expense for these puts and calls.
Working capital existing at the date of affiliation has generally been
retained in the physician practices. Therefore, additional working capital
investment is generally only required to the extent billing processing is slowed
during payor administrative changes after an affiliation and also to fund growth
of revenues. The Company and its Affiliated Groups had total net accounts
receivable of $5.4 million at December 31, 1996, and of $7.8 million at
September 30, 1997.
The Company currently anticipates that its and the Affiliated Group's
capital expenditures during 1997 will be approximately $1.5 million.
The Company has executed a contract with HBO and Company that obligates the
Company to purchase $1.1 million of equipment and licenses pertaining to
practice management systems. The term of the contract is five years.
On December 31, 1996 and February 12, 1997, the Company issued an aggregate
of 614,000 additional shares of Class A Common Stock at $2.50 per share for a
total consideration of approximately $1.5 million. During the period from June
1997 to August 1997, the Company issued an aggregate of 643,800 shares of Class
A Common Stock at $2.50 per share for a total consideration of $1.5 million.
At April 21, 1997, Bain Capital, Inc. had $18.5 million of unused
commitment to purchase the Company's Class B Common Stock. Such commitment was
terminated on June 20, 1997 in connection with the amendment of the agreement
with certain institutional investors at which time $25 million was issued in
consideration for the issuance of 7,692,309 shares of Class C Common Stock. An
additional $20 million in shares of Class C Common Stock may be issued in the
future. The purchase of such additional shares of Class C Common Stock is at
the option of institutional investors and there can be no assurance that such
equity capital will be available when needed. The Company has also agreed with
such institutional investors that it will not use other sources of equity or
debt financing, other than bank financing, without the consent of the
13
<PAGE>
institutional investors.
On January 16, 1997, the Company entered into a Credit Agreement with
Bankers Trust, as Agent, and the lenders from time to time a party thereto (the
"Credit Agreement"), pursuant to which the lenders have agreed, subject to the
terms and conditions set forth in the Credit Agreement, to provide a revolving
credit facility to the Company in an aggregate amount of up to $3.5 million,
subject to downward adjustment in the event that the Company and the Affiliated
Groups do not maintain an adequate amount of accounts receivable. On September
30, 1997, there was $400,000 outstanding under the credit facility and the
remaining available commitment on such date was $3.1 million. The Company
repaid the outstanding balance on October 21, 1997 and at present has $3.5
million in available commitment. The Company will need to repay or refinance
the outstanding balance, if any, under the Credit Agreement when the credit
facility terminates in January 1998. There can be no assurance that the Company
will be able to enter into a replacement credit facility on terms favorable to
the Company.
PART II
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
11.1 Statement regarding computation of per share loss
27 Financial Data Schedule
99.1 Pages 13 through 22 of the Registrant's Prospectus dated
November 12, 1997 included in the Registrant's
Registration Statement on Form S-1 (Registration No. 333-
26137) as filed with the Securities and Exchange
Commission on November 12, 1997 (which is not deemed filed
except to the extent that portions thereof are expressly
incorporated by reference herein)
(b) Reports on Form 8-K
The Registrant filed a Form 8-K on December 16, 1997 in
connection with the affiliation of Clinical Associates, P.A. with
the Registrant.
14
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Date: December 29, 1997 PHYSICIANS QUALITY CARE, INC.
By: /s/ Samantha Trotman
-------------------------------------
Samantha Trotman
Chief Financial Officer and
Vice President
15
<PAGE>
EXHIBIT INDEX
Exhibits
11.1 Statement regarding computation of per share loss
27 Financial Data Schedule
99.1 Pages 13 through 22 of the Registrant's Prospectus dated
November 12, 1997 included in the Registrant's
Registration Statement on Form S-1 (Registration No. 333-
26137) as filed with the Securities and Exchange
Commission on November 12, 1997 (which is not deemed filed
except to the extent that portions thereof are expressly
incorporated by reference herein)
<PAGE>
Exhibit 11.1 - Computation of Earnings Per Share
Physicians Quality Care, Inc.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
Primary and Fully-diluted earnings ----------------------- ------------------------
per share(1) 1996 1997 1996 1997
----------------------- ------------------------
<S> <C> <C> <C> <C>
Net loss $ 967,138 $1,227,448 $ 3,280,488 $ 3,683,344
Accretion on common stock subject to
fair value put (2) 14,436,848 14,436,848 6,656,541
----------------------- ------------------------
Net loss available to common
stockholders $15,403,986 $1,227,448 $17,717,336 $10,339,885
====================== ========================
Weighted average common shares
outstanding 10,870,020 34,002,120 9,228,584 28,528,490
====================== ========================
Primary and fully-diluted loss per
common share $ 1.42 $ 0.04 $ 1.92 $ 0.36
====================== ========================
</TABLE>
(1) The effect of options, warrants and convertible securities are not
considered as it would be antidilutive.
(2) Calculated as follows:
<TABLE>
<CAPTION>
Three and Nine Months Nine Months Ended
Ended September 30, 1996 September 30, 1997
------------------------ ------------------
<S> <C> <C>
Per share fair value of common stock $ 2.50 $ 3.00
Recorded per share value .01 2.50
----------- -----------
Per share accretion adjustment $ 2.49 $ .50
Common shares subject to fair value put 5,797,930 13,313,082
----------- -----------
$14,436,848 $ 6,656,541
=========== ===========
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE AUDITED
AND UNAUDITED FINANCIAL STATEMENTS OF THE COMPANY FOR THE YEAR ENDED DECEMBER
31, 1996 AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997, RESPECTIVELY, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> YEAR 9-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1997
<PERIOD-START> JAN-01-1996 JAN-01-1997
<PERIOD-END> DEC-31-1996 SEP-30-1997
<CASH> 136,926 18,380,715
<SECURITIES> 0 0
<RECEIVABLES> 0 0
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 1,915,769 24,424,049
<PP&E> 271,782 1,292,053
<DEPRECIATION> 57,774 289,131
<TOTAL-ASSETS> 35,397,744 60,920,118
<CURRENT-LIABILITIES> 2,773,808 748,298
<BONDS> 271,552 63,847
31,851,473 39,939,247
0 0
<COMMON> 112,359 207,872
<OTHER-SE> (470,811) 18,541,653
<TOTAL-LIABILITY-AND-EQUITY> 35,397,744 60,920,118
<SALES> 6,026,452 31,835,291
<TOTAL-REVENUES> 6,117,556 32,146,592
<CGS> 0 0
<TOTAL-COSTS> 10,779,966 34,864,662
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 214,404 835,916
<INTEREST-EXPENSE> 104,255 129,358
<INCOME-PRETAX> (4,981,069) (3,683,344)
<INCOME-TAX> 78,128 0
<INCOME-CONTINUING> (5,059,197) (3,683,344)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (5,059,197) (3,683,344)
<EPS-PRIMARY> (1.81) (0.36)
<EPS-DILUTED> 0 0
</TABLE>
<PAGE>
Exhibit 99.1
RISK FACTORS
In evaluating the Company and its business, prospective investors
should carefully consider the following risk factors, in addition to the other
information contained elsewhere in this Prospectus.
Lack of Operating History; History of Operating Losses; Going Concern
Qualification in Financial Statements
The Company was formed in March 1995, the first group of physicians
affiliated with the Company in August 1996 and a majority of the current
physicians affiliated with the Company in December 1996. Accordingly, the
Company's historical financial condition and results of operations may not be
indicative of the Company's results of operations and financial condition for
future periods. For the period from March 20, 1995 (inception) to December 31,
1995, the Company recorded a net loss of $2,082,264, for the year ended December
31, 1996, the Company recorded a net loss of $4,973,188 and for the six-month
period ended June 30, 1997, the Company recorded a net loss of $2,209,610. The
Company expects to incur operating losses for at least the immediate future and
to fund such operating losses through the issuance of additional equity and debt
securities. See "-- Need for Substantial Additional Capital." There can be no
assurance that the Company will achieve or maintain profitability. The report of
Ernst & Young LLP, PQC's independent public accountants, on the Company's
financial statements for the year ended December 31, 1996, and Note 2 to such
financial statements which are included in this Prospectus, describe an
uncertainty about the Company's ability to continue as a going concern. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business."
Need for Substantial Additional Capital
The Company will require substantial capital resources to obtain the
necessary scale to become profitable and to fulfill its business plan.
Additional funds will be required to fund the acquisition, integration,
operation and expansion of affiliated practices, capital expenditures including
the development of the information systems to manage such practices, operating
losses and general corporate purposes. Through June 20, 1997, the Company has
satisfied its capital requirements through the issuance of $11.5 million of
Class B Common Stock to affiliates of Bain Capital, Inc. ("Bain Capital"),
private offerings of Class A Common Stock and a $3.5 million line of credit with
Banker's Trust Company ("Banker's Trust") as Agent, and the lenders from time to
time a party thereto (the "Credit Agreement"). On June 23, 1997, the Company
issued 7,692,309 shares of Class C Common Stock to the Institutional Investors
for an aggregate consideration of $25 million. Under the agreement with the
Institutional Investors (the "Equity Facility"), the Institutional Investors, at
their option, may purchase up to $20 million of Class C Common Stock in
addition to their rights under outstanding warrants. See "Business - Equity
Financing." The Company expects that this additional capital will be sufficient,
depending upon the Company's operating results and the consideration paid in
connection with the Affiliations, to satisfy the Company's projected capital
requirements for the next year. For the year ended December 31, 1996 and the
six-months ended June 30, 1997, net cash used by the Company in operating
activities were $5.7 million and $5.9 million respectively. If PQC continues to
incur operating losses, the Company would not be able to continue as a going
concern without access to additional sources of capital.
To date, a significant portion of the consideration paid in affiliation
transactions has been in the form of Class A Common Stock. If the percentage of
cash required to finance future affiliation transactions increases
significantly, the Company's capital requirement will also significantly
increase.
The Credit Agreement has significant financial and other conditions to
its continued availability and to avoid a default and there can be no assurance
that such conditions will be satisfied when capital is sought. The remaining
amount under the Equity Facility is only available with the consent of the
Institutional Investors. The Company's ability to meet the financial conditions
is dependent upon a significant increase in revenues and income from future
affiliation transactions and improved productivity of the Springfield and
Flagship Affiliated Groups. The Equity Facility also restricts the sources of
capital available to the Company without the consent of the Institutional
Investors. There can also be no assurance that the Company will be able to
refinance the Credit Agreement when the outstanding balance becomes due in
13
<PAGE>
January 1998. See "Business -- The Equity Financing" and "Business -- The Credit
Agreement." Except for the Credit Agreement, the Company has no committed
external sources of capital. Without the consent of the director elected by the
stockholders of the Class B-1 Common Stock (the "Class B-1 Director"), the
director elected by the stockholders of the Class B-2 Common Stock (the "Class
B-2 Director," and together with the Class B-1 Director the "Class B Directors")
and the directors elected by the holders of Class C Common Stock (the "Class C
Directors"), the Company may not obtain additional financing through external
borrowings or the issuance of additional securities. The issuance of additional
Capital Stock could have an adverse effect on the value of the shares of Common
Stock held by the then existing stockholders. There can be no assurance that the
Class B Directors and Class C Directors will approve such capital raising
activities or that the Company will be able to raise additional capital when
needed on satisfactory terms or at all. The failure to obtain additional
financing when needed and on appropriate terms could have a material adverse
effect on the Company.
Absence of Trading Market for Common Stock
No trading market for the Common Stock of the Company currently exists.
The Common Stock is not listed on a stock exchange or traded through the
National Association of Securities Dealers, Inc. There can be no assurance that
a public market in the Common Stock will develop in the future and the Company
does not expect such a market to develop until such time, if any, that the
Company completes a public offering of its securities other than to Stockholder
Physicians.
Contractual Restriction on Resale of Common Stock
The Equity Facility requires that most current and all future
stockholders of the Company become parties to a Stockholders Agreement dated as
of August 30, 1996 (the "Stockholders Agreement"), which agreement, among other
things, contains provisions which significantly limit the transferability of the
Class A Common Stock and provide the Company with a right to purchase Class A
Common Stock from Stockholder Physicians who are parties to such Stockholders
Agreement upon their termination of employment. Consequently, an investment in
the Common Stock should only be considered as a long-term investment and is
extremely illiquid. Stockholders will be required to make their own judgment as
to the value of their shares without the benefit of an independent market price.
In circumstances where the Company is entitled to repurchase the Common Stock of
a Physician Stockholder upon death or termination of the Physician Stockholder's
employment by an Affiliated Group or the right of the Physician Stockholders to
sell the Common Stock to the Company upon a Physician Stockholder's death, the
fair market value of the Common Stock, if a public market has not yet developed,
will be determined by the Board of Directors of the Company. See "Description of
Capital Stock -- Stockholders Agreement."
Risk that Future Affiliation Transactions Will Not Be Consummated; Costs of
Affiliation Transactions
There can be no assurance that the Clinical Associates transaction or
any future affiliation transactions will be consummated. There is no assurance
that the Company would be able to use the shares registered in this offering to
affiliate with additional medical practices on acceptable terms. In consummating
these future affiliation transactions, the Company will rely upon certain
representations, warranties and indemnities made by sellers with respect to the
affiliation transaction, as well as its own due diligence investigation. There
can be no assurance that such representations and warranties will be true and
correct, that the Company's due diligence will uncover all material adverse
facts relating to the operations and financial condition of the affiliated
medical practices or that all of the conditions to the Company's obligations to
consummate these future affiliations will be satisfied. Any material
misrepresentations could have a material adverse effect on the Company's
financial condition and results of operations. See "Business - Company
Strategy."
The Company has incurred significant (approximately $4.3 million during
1996) accounting, legal and other costs in developing its affiliation structure
and completing its initial affiliation transactions. The Company's ability to
enter into affiliation transactions with a significant number of physicians and
to achieve positive cash flow will be adversely affected unless it is able to
reduce the expenses associated with future
14
<PAGE>
transactions. There can be no assurance that the Company will be able to reduce
transaction costs on a per affiliated physician basis in the future.
Dependence upon Affiliated Medical Practices
Although the Company does not and will not employ physicians or control
the medical aspects of the practices of the physicians employed by the
Springfield Affiliated Group, the Flagship Affiliated Group or similar
Affiliated Groups, the Company's revenue and profitability are directly
dependent on the revenue generated by the operation and performance of and
referrals among the affiliated medical practices. The compensation to the
Company under its Services Agreements with the Affiliated Groups is based upon a
percentage of the profits or revenues generated by the Affiliated Groups'
practices with a substantial portion of the profits or revenues being allocated
to the physicians until threshold levels of income or revenues, based upon the
physicians' historical compensation or billings, are achieved. Accordingly, the
performance of affiliated physicians affects the Company's profitability and the
success of the Company depends, in part, upon an increase in net revenues from
the practice of affiliated physicians compared to historical levels. The
inability of the Company's Affiliated Groups to attract and retain patients, to
manage patient care effectively and to generate sufficient revenue or a material
decrease in the revenues of the Affiliated Groups would have a material adverse
effect on the financial performance of the Company. To the extent that the
physicians affiliated with the Company are concentrated in a limited number of
target markets, as is currently the case in western Massachusetts and Maryland,
deterioration in the economies of such markets could have a material adverse
effect upon the Company. See "Business - Company Strategy" and " - Affiliation
Structure".
Risks Related to Expansion of Operations
Integration Risks. The Company has completed in the past nine months
the initial transactions with the Springfield Affiliated Group and the Flagship
Affiliated Group, is in the process of closing the Clinical Associates
transaction, and is seeking to enter into Affiliations with additional
physicians. In the Springfield and Greater Baltimore-Annapolis areas and in
other potential affiliation markets, the Company is integrating physician
practice groups that have previously operated independently. The Company is
still in the process of integrating its affiliated practices. The Company may
encounter difficulties in integrating the operations of such physician practice
groups and the benefits expected from such affiliations may not be realized. Any
delays or unexpected costs incurred in connection with integrating such
operations could have an adverse effect on the Company's business, operating
results or financial condition.
While each Affiliation conforms to PQC's overall business plan, the
profitability, location and culture of the physician practices that have been
combined into Affiliated Groups are different in some respects. PQC's management
faces a significant challenge in its efforts to integrate and expand the
business of the Affiliated Groups. The need for management to focus upon such
integration and future Affiliations may limit resources available for the
day-to-day management of the Company's business. While management of the Company
believes that the combination of these practices will serve to strengthen the
Company, there can be no assurance that management's efforts to integrate the
operations of the Company will be successful. The profitability of the Company
is largely dependent on its ability to develop and integrate networks of
physicians from the affiliated practices, to manage and control costs and to
realize economies of scale. There can be no assurances that there will not be
substantial costs associated with such activities or that there will not be
other material adverse effects on the financial results of the Company as a
result of these integration and affiliation activities.
The Company intends to continue to pursue an aggressive growth strategy
through affiliations and internal development for the foreseeable future. The
Company's ability to pursue new growth opportunities successfully will depend on
many factors, including, among others, the Company's ability to identify
suitable growth opportunities and successfully integrate affiliated or acquired
businesses and practices. There can be no assurance that the Company will
anticipate all of the changing demands that expanding operations will impose on
its management, management information systems and physician network. Any
failure by the Company to adapt its systems and procedures to those changing
demands could have a material adverse effect on the operating results and
financial condition of the Company.
15
<PAGE>
Need to Hire and Retain Additional Physicians. The success of the
Company is dependent upon its ability to affiliate with a significant number of
qualified physicians and the willingness of such affiliated physicians to
maintain and enhance the productivity of their practices following affiliation
with PQC. The market for affiliation with physicians is highly competitive, and
the Company expects this competition to increase. The Company competes for
physician affiliations with many other entities, some of which have
substantially greater resources, greater name recognition and a longer operating
history than the Company and some of which offer alternative affiliation
strategies which the Company may not be able to offer. In addition, under
current law the Company has no or only limited ability to enforce restrictive
covenants in the employment agreements with the physicians with whom the Company
affiliates. The Company is subject to the risk that physicians who receive
affiliation payments may discontinue such affiliation with the Company,
resulting in a significant loss to the Company and a decrease in the patient
base associated with such affiliated physicians. There can be no assurance that
PQC will be able to attract and retain a sufficient number of qualified
physicians. If the Company were unable to affiliate with and retain a sufficient
number of physicians, the Company's operating results and financial condition
would be materially adversely affected. A material increase in costs of
affiliations could also adversely affect PQC and its stockholders.
Risk of Inability to Manage Expanding Operations. The Company is
seeking to expand its operations rapidly, which, if successful, will create
significant demands on the Company's administrative, operational and financial
personnel and systems. There can be no assurance that the Company's systems,
procedures, controls and staffing will be adequate to support the proposed
expansion of the Company's operations. The Company's future operating results
will substantially depend on the ability of its officers and key employees to
integrate the management of the Affiliated Groups, to implement and improve
operational, financial control and reporting systems and to manage changing
business conditions.
Dependence Upon the Growth of Numbers of Covered Lives. The Company is
also largely dependent on the continued increase in the number of covered lives
under managed care and capitated contracts. This growth may come from
affiliation with additional physicians, increased enrollment with managed care
payors currently contracting with the Affiliated Groups and additional
agreements with managed care payors. A decline in covered lives or an inability
to increase the number of covered lives under contractual arrangement with
managed care or capitated payors could have a material adverse effect on the
operating results and financial condition of the Company.
Risks of Industry Integration and Consolidation
The healthcare industry is in the process of rapid and fundamental
change, triggered by the deregulation of the acute care hospital reimbursement
system in many states and the growing strength of managed care plans. The growth
of the managed care industry is being driven, in part, by increasing pressure
from employers and other purchasers who are seeking to reduce their healthcare
premium costs. As the healthcare market in many states shifts from a heavily
regulated, largely fee-for-service payment system towards a deregulated,
capitated payment system, large integrated delivery systems are developing.
These systems are intended to provide adequate geographical coverage for major
purchasers of healthcare and to provide a system in which significant cost
savings can be realized from efficiencies resulting from the alignment of the
financial interests of physicians and other providers. Many of these integrated
systems may be substantially larger and better capitalized than the Company. In
addition, the rapidly changing alignment of numerous market participants creates
an uncertain environment in which it may be difficult for smaller market
participants, such as the Company, to implement an effective strategic plan. The
Company's inability to implement its business strategy could have a material
adverse effect on the Company. See "Business-Industry Overview" "- Competition."
Potential Regulatory Restraints Upon the Company's Operations
The healthcare industry is subject to extensive federal and state
regulation. Changes in the regulations or interpretations of existing
regulations could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business -- Governmental
Regulations."
16
<PAGE>
Prohibition on Corporate Practice of Medicine. The laws of most states,
including Massachusetts and Maryland, prohibit business corporations such as the
Company from practicing medicine or employing physicians to do so. The
contractual relationships with the Affiliated Groups are designed to comply with
these laws. Because there is very limited judicial or regulatory interpretation
of the scope of these laws in most states, however, there can be no assurance
that the Company's contractual arrangements will be found to comply with such
laws. Any determination that such contractual relationships violate such laws
could have a material adverse effect on the Company, and there can be no
assurance that the Company would be able to restructure its arrangements on
favorable terms or at all.
The Massachusetts Board of Registration in Medicine (the "BRM") has
proposed regulations that, if promulgated as proposed, might limit physicians
licensed within the Commonwealth of Massachusetts in entering into management
contracts with proprietary business entities unless a majority of the governing
board of those business entities are licensed physicians and certain other
conditions are met. The BRM also indicated that it may seek to limit
significantly the extent to which proprietary business entities may have control
or consultation rights with respect to medical decisions or business decisions
that may affect patient care, such as the amount of time each physician spends
with a patient. Extensive commentary has been filed in opposition to the
proposed regulations, and it is not known whether, when or in what form final
regulations will be promulgated. The final regulations may have a material
adverse effect on the Company's relationship with the Springfield Affiliated
Group and its ability to operate in Massachusetts as currently contemplated.
Comparable regulations have not been proposed in Maryland, but there can be no
assurance that such regulations will not be proposed or adopted.
Stark Law. The federal law commonly known as the "Stark law"
significantly limits the ability of physicians to maintain any ownership or
other financial relationship with an entity (including their own group practice)
to which they refer patients for a broad class of "designated health services",
including ancillary services such as laboratory and radiology services. The
Stark law is extremely broad and complex, and extensive regulations have been
promulgated governing the application of the Stark law to physician
relationships with clinical laboratories. These clinical laboratory regulations
are difficult to apply to many common situations, and regulations have not yet
been issued applying the law to other designated health services. However, the
government has indicated that it will look to the regulations applicable to
clinical laboratories for guidance with respect to the law's application to
other designated health services. Significant monetary penalties and denial of
reimbursement may be assessed for violation of the Stark law, and a provider may
be excluded from the Medicare and state health programs in certain instances. In
addition, violation of the Stark law may result in assertion of a federal false
claim, which could result in civil and criminal penalties. The assertion or
determination that the Company's contractual relationship with the physicians
employed by the Affiliated Groups or the relationship of the physicians within
one or more Affiliated Groups was in violation of the Stark law could have a
material adverse effect on the Company. In addition, there can be no assurance
that, in the event of such assertion, the Company would be able to restructure
its relationships with the Affiliated Groups upon favorable terms or at all.
Fraud and Abuse Laws. Federal law and the laws of many states prohibit
the offer, payment, solicitation or receipt of any form of remuneration in
return for the referral of Medicare or state health program (such as Medicaid)
patients or in return for the purchase or order of items or services that are
covered by Medicare or state health programs. These laws are commonly referred
to as the "fraud and abuse" laws. Violations of the fraud and abuse laws may
result in substantial civil or criminal penalties for individuals or entities,
including large monetary penalties and exclusion from participation in the
Medicare and state health programs. The Company has attempted to structure its
contractual relationships with the Affiliated Groups so as to avoid violating
the fraud and abuse laws, but in view of the broad and ambiguous nature of such
laws and the lack of applicable safe harbor exceptions, there can be no
assurance that the Company's contractual relationships with the Affiliated
Groups comply with such laws. Any allegation or determination that the Company
or the Affiliated Groups have violated the fraud and abuse laws could have a
material adverse effect on the Company.
Healthcare Reform. The United States Congress has considered various
types of healthcare reform, including comprehensive revisions to the current
healthcare system. It is uncertain what legislative proposals
17
<PAGE>
will be adopted in the future, if any, or what actions federal or state
legislatures or third party payors may take in anticipation of or in response to
any healthcare reform proposals or legislation. Healthcare reform legislation
adopted by Congress could, among other things, result in lower payment levels
for the services of physicians managed by the Company and lower profitability
for the Affiliated Groups, which could have a material adverse effect on the
operations of the Company.
Insurance Laws. Laws in all states regulate the business of insurance
and the operation of health maintenance organizations ("HMOs"). Many states also
regulated the establishment and operation of networks of healthcare providers.
While these laws do not generally apply to the hiring and contracting of
physicians by other healthcare providers, there can be no assurance that
regulatory authorities of the states in which the Company operates would not
apply these laws to require licensure of the Company's operations as an insurer,
as an HMO or as a provider network.
Risks of Capitated Contracts
The physician groups with which the Company is affiliated and proposes
to affiliate are parties to certain capitated contracts with third party payors,
such as insurance companies. The Company intends to seek to expand the capitated
patient base of its Affiliated Groups, particularly for Medicare enrollees. In
general, risk contracts pay a flat dollar amount per enrollee in exchange for
the physician's obligation to provide or arrange for the provision of a broad
range of healthcare services (including in-patient care) to the enrollee. A
significant difference between a full risk capitated contract and traditional
managed care contracts is that the physician is sometimes responsible for both
professional physician services and many other healthcare services, e.g.,
hospital, laboratory, nursing home and home health. The physician is not only
the "gatekeeper" for enrollees, but is also financially at risk for
over-utilization and for the actuarial risk that certain patients may consume
significantly more healthcare resources than average for patients of similar age
and sex (such patients are referred to herein as "high risk patients").
While physicians often purchase reinsurance to cover some of the
actuarial risk associated with high risk patients, such insurance typically does
not apply with respect to the risk of over-utilization until a relatively high
level of aggregate claims has been experienced and therefore does not completely
protect against any capitation risk assumed. If over-utilization occurs with
respect to a given physician's enrollees (or the physician's panel of enrollees
includes a disproportionate share of high risk patients not covered by
reinsurance), the physician is typically penalized by failing to receive some or
all of the physician's compensation under the contract that is contingent upon
the attainment of negotiated financial targets, or the physician may be required
to reimburse the payor for excess costs. In addition, a physician may be liable
for over-utilization by other physicians in the same "risk pool" and for
utilization of ancillary, in-patient hospital and other services when the
physician has agreed contractually to manage the use of those services. Neither
the Company nor the Affiliated Groups currently maintain any reinsurance
arrangement and, to date, the Affiliated Groups have not experienced losses from
participation in risk pools or incurred any material penalties or obligations
with respect to excess costs under capitated contracts. The participation of the
Flagship Affiliated Group under capitated contracts will significantly increase
after the Clinical Associates transaction. Also, the Company is pursuing a
strategy of seeking increased participation in capitated contracts for all of
its affiliated physicians. As the percentage of the Company's revenues derived
from capitated contracts increases, the risk of the Company experiencing losses
under capitated contracts increases. As the revenues from capitated contracts
became of increasing importance to PQC and its Affiliated Groups, the Company
will review the financial attractiveness of reinsurance arrangements.
Medical providers, such as the Affiliated Groups, are experiencing
increasing pricing pressure in negotiating capitated contracts while facing
increased demands on the quality of their services. If these trends continue,
the costs of providing physician services could increase while the level of
reimbursement could grow at a lower rate or decrease. Because the Company's
financial results are dependent upon the profitability of such capitated
contracts, the Company's results will reflect the financial risk associated with
such capitated contracts. See "Business -- Industry Overview." Liabilities or
insufficient revenues under capitated and other risk-sharing arrangements could
have a material adverse effect on the Company.
18
<PAGE>
Risks of Changes in Payment for Medical Services.
The profitability of the Company may be adversely affected by Medicare
and Medicaid regulations, cost containment decisions of third party payors and
other payment factors over which PQC and its Affiliated Groups have no control.
The federal Medicare program has undergone significant legislative and
regulatory changes in the reimbursement and fraud and abuse areas, including the
adoption of the resource-based relative value scale ("RBRVS") schedule for
physician compensation under Medicare, which may have a negative impact on PQC's
revenue. Efforts to control the cost of healthcare services are increasing.
PQC's Affiliated Groups contract with provider networks, managed care
organization and other organized healthcare systems, which often provided fixed
fee schedules or capitation payment arrangements which are lower than standard
charges. Future profitability in the changing healthcare environment, with
differing methods of payment for medical services, is likely to be affected
significantly by management of healthcare costs, pricing of services and
agreements with payors. Because PQC derives its revenues from the revenues
generated by its affiliated physician groups, further reductions in payment to
physicians generally or other changes in payment for healthcare services could
have an adverse effect on the Company.
Exposure to Professional Liability; Liability Insurance
In recent years, physicians, hospitals and other participants in the
healthcare industry have become subject to an increasing number of lawsuits
alleging medical malpractice, negligent credentialing of physicians, and related
legal theories. Many of these lawsuits involve large claims and substantial
defense costs. There can be no assurance that the Company will not become
involved in such litigation in the future. Through its management of practice
locations and provision of non-physician healthcare personnel, the Company could
be named in actions involving care rendered to patients by physicians or other
practitioners employed by Affiliated Groups. In addition, to the extent that
affiliated physicians are subject to such claims, the physicians may need to
devote time to defending such claims, adversely affecting their financial
performance for the Company, and potentially having an adverse effect upon their
reputations and client base. The Company and the Affiliated Groups maintain
professional and general liability insurance, which is currently maintained at
$1 million per occurrence and $3 million annually for each affiliated physician.
Nevertheless, certain types of risks and liabilities are not covered by
insurance, and there can be no assurance that the limits of coverage will be
adequate to cover losses in all instances.
Certain Federal Income Tax Considerations
Physician groups which operated as professional corporations ("PCs") in
Springfield prior to affiliating with the Company were merged into the
Springfield Affiliated Group, with stockholders of each PC receiving shares of
Class A Common Stock of the Company and cash in exchange for their capital stock
in the PC. Physician groups which operated as professional associations ("PAs")
in the greater Baltimore-Annapolis area prior to affiliating with the Company
were similarly merged into the Flagship Affiliated Group, with stockholders of
each PA receiving shares of Class A Common Stock of the Company and cash in
exchange for their capital stock in the PA. Each such merger is intended to
qualify as a "reorganization" under Section 368(a) of the Internal Revenue Code
of 1986, as amended (the "Code"), in which case no gain or loss would generally
be recognized by the PC or PA or the stockholders (other than as cash received)
of the PC or PA. The Company has not sought or obtained a ruling from the
Internal Revenue Service or an opinion of counsel with respect to the tax
treatment of the mergers of PCs or PAs into the Springfield or Flagship
Affiliated Groups. The Company does not believe that the Internal Revenue
Service is issuing rulings at this time on transactions using the Company's
affiliation structure. If a merger were not to so qualify, the exchange of
shares would be taxable to the stockholders of the PC or PA, and the
consideration (net of asset basis) issued in connection with the merger would be
taxable to the Affiliated Group into which such PC or PA was merged. Because of
such tax liability, failure of a merger or mergers to qualify as tax-free
reorganizations could have a material adverse effect on the applicable
Affiliated Group and the Company. Also, the inability to structure future
Affiliations on a tax deferred basis may adversely affect the Company's ability
to attract additional physicians.
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New Management; Dependence on Key Personnel
The current management structure and the senior management team of the
Company have been in place for a relatively short time. The Company's future
success depends, in large part, on the continued service of Jerilyn P. Asher,
the Chief Executive Officer, and on PQC's ability to continue to attract,
motivate and retain highly qualified senior management and employees. The
Company has an employment agreement with Ms. Asher. See "Management." The
Company does not maintain key person life insurance with respect to Ms. Asher.
As a development stage company, PQC has experienced some turnover in staff,
including two of the founding officers. The Company and one of the departed
founders are currently in a dispute concerning the vesting of approximately
400,000 shares of Class A Common Stock granted to the founder and the founder's
right to severance payments of approximately $440,000. See "Business - Legal
Proceedings." Although the Company has entered into employment agreements with
certain of its other executives that contain covenants not to compete with the
Company, there can be no assurance that the Company will be able to retain such
key executives or its senior managers and employees. The inability to hire and
retain qualified personnel or the loss of the services of personnel could have a
material adverse effect upon the Company's business and future business
prospects. The Company's Compensation Committee currently only has one member.
See "Management."
Risks Related to the Equity Financing
Risk of the unavailability of the Equity Facility. The $20 million
remaining under the Equity Facility is only available with the consent of the
Institutional Investors and there can be no assurance that the Institutional
Investors will be willing to provide additional capital when needed by the
Company. The Equity Facility also restricts the sources of capital available to
the Company without the consent of the Institutional Investors. Except for the
Equity Facility, the Company has no committed external sources of capital.
Except with the consent of the director elected by the Institutional Investors,
the Company may not obtain additional financing through external borrowings or
the issuance of additional securities. The Institutional Investors also have
received warrants to purchase a substantial number of shares of Class A Common
Stock. These warrants are exercisable at $2.50 or $3.25 per share, which
exercise price may be substantially below the fair market value of the Class A
Common Stock at the time of exercise. Any additional equity issuance could have
an adverse effect on the value of the shares of Class A Common Stock held by the
then existing stockholders. See "Business - Equity Financing."
Voting Control by Institutional Investors. Pursuant to the Company's
Restated Certificate of Incorporation (the "Restated Certificate") and the
Stockholders Agreement, the Institutional Investors have the right to appoint
the Class B and C Directors, four of the thirteen members (with one position to
remain vacant until such time as the remaining amount to be purchased by
affiliates of Goldman, Sachs & Co. under the Equity Facility is drawn down) of
the Board of Directors of the Company and the Institutional Investors have the
right to approve seven of the other directors. The Class B and C Directors are
entitled to five votes each, giving them a majority of the voting power of the
Board of Directors, (i) with respect to certain actions of the Company,
including public offerings, issuances and redemptions of equity securities,
declarations of dividends, incurrences of debt, mergers, assets sales and
liquidation of the Company and its affiliates, material amendments to the
management agreements between the Company and its affiliates and employment of
the Chief Executive Officer, and (ii) with respect to any matter before the
Board of Directors upon the occurrence of certain events, including the failure
of the Company to meet certain financial objectives. In addition to being
approved by the Board of Directors, certain actions of the Company, including
mergers, material asset sales, liquidation, certain medical practice affiliation
transactions, dividends, material changes in the business of the Company or its
affiliates, retention and dismissal of the Chief Operating and Financial
Officers, transactions with affiliates and commencement and management of
material litigation, must be approved by the Institutional Investors. See
"Business--Equity Financing" and "Description of Capital Stock." As a result of
those provisions of the Restated Certificate and "drag-along" rights in the
Stockholders Agreement, the Institutional Investors have significant control
over the actions of the Company including if and when the Company is sold to a
third party or a public market for the Company Common Stock is established.
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Risks from Put and Other Rights Held by Certain Stockholders.
Each physician and management stockholder who is a party to the
Stockholders Agreement, dated as of August 30, 1996, has the right to require
PQC to purchase the Common Stock owned by such stockholder at fair market value
upon their death or disability. Pursuant to the Stockholders Agreement, fair
market value, as determined by the Board of Directors, reflects an arms-length
private sale. In determining the fair market value, the Board is to consider
recent arms-length sales by the Company and the stockholders, as well as other
factors considered relevant. While the Stockholders Agreement does not limit the
Board's discretion, such other factors may include changes, since the last arms-
length sale, in the Company's financial conditions or prospects and any
valuation studies conducted by management of the Company or independent
valuation experts. Under the Stockholder Agreement, the Board is not permitted
to discount the fair market value of the Common Stock to reflect the fact that
the Common Stock being sold constitutes less than a majority of the outstanding
shares. The put option is only triggered by death or disability (and in a few
instances retirement) and will terminate upon the completion of a public
offering which results in at least $50.0 million in gross revenues to the
Company and which meets certain other criteria. To the extent that the "put
options" are likely to be exercised, the Company expects to fund such
repurchases from working capital, the Equity Facility or other sources. If the
Clinical Associates transaction is completed, the physician affiliated with
Clinical Associates will have the right to require the Company to repurchase
their Common Stock at $3.00 per share (in the form of a five year, non-interest
bearing note) in the event that the Company has not completed an initial public
offering with four years. The exercise of such right could have a material
adverse effect upon the Company.
Immediate and Substantial Dilution
Persons receiving shares of Class A Common Stock of the Company in the
expected transaction with Clinical Associates will incur an immediate and
substantial dilution of approximately 79% of their investment in such shares
because the net tangible book value of the Company Common Stock after such
transaction would be approximately $.63 per share as compared with the
anticipated $3.00 per share valuation of the Class A Common Stock in such
transactions. In addition, assuming the exercise of the repurchase rights
described above in determining such per-share dilution, recipients of such
shares, would incur immediate and substantial dilution of approximately 139% of
their investments in such shares because the net tangible book value of the
Company Common Stock after such transaction would be approximately $(1.18) per
share as compared with the anticipated $3.00 per share valuation of the Class A
Common Stock in such transaction. See "Dilution".
The Company expects to continue to issue Class A Common Stock as a
principal component of the consideration for future affiliation transactions. To
the extent that all or a portion of future affiliation transactions are paid in
cash, the Company may need to issue additional equity securities to fund such
payment or to fund anticipated operating losses. If the Company achieves its
goal of affiliating with a significant number of physicians, the number of
shares issued may be substantial, resulting in further dilution to the
stockholders of the Company at that time of any such affiliation.
Conflicts of Interest
Certain conflicts of interest are inherent in the structure of the
Company and its contractual and organizational relationships. The President of
the Springfield Affiliated Group (who is also a director of the Company) is a
practicing physician in the Springfield Affiliated Group, the president of the
Flagship Affiliated Group is a practicing physician in the Flagship Affiliated
Group and two directors of the Company, one of whom is also President of the
Company, are practicing physicians in the Flagship Affiliated Group. Four
directors of the Company are appointed by the Institutional Investors which are
the primary financing source for the Company. From time to time, the interests
of such persons, and persons serving in multiple roles in existing and future
affiliation transactions, may conflict with those of the Company due to such
relationships. The Company seeks to minimize or avoid such conflicts of interest
through contractual arrangements with the Affiliated Group that clearly specify
the responsibilities of PQC and the physicians in the Affiliated Groups, dispute
resolution structures, such as the Joint Policy Boards established with respect
to each Affiliated Group, at which certain issues are required to be addressed,
contractual arrangements with the Institutional Investors and the careful
selection of the individuals who occupy such multiple roles. See also "-- Voting
Control" and "Certain Transactions."
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Antitrust Considerations
The Company, its affiliated physicians and other entities with which it
contracts are subject to the United States and state antitrust statutes. Because
the Company will be contracting with third party payors and other entities who
could be deemed to compete with the Company or its Affiliated Groups, and for
other reasons, the Company, its affiliated physicians and other entities with
which it contracts could be subject to public and private investigations and
enforcement actions under such statutes. The Company believes that, given its
small size relative to its competitors and the overall market for physician
services, it is currently in compliance with applicable federal and state
anti-trust laws. However, as the Company and its Affiliated Groups increase in
size, particularly within specific markets, federal and state anti-trust laws
may act as a practical constraint upon the Company's expansion and operations.
Amortization of Intangible Assets
In connection with its Affiliations, the Company has recorded, and is
expected to continue to record, a significant amount of intangible assets as the
consideration paid to physicians exceeds the value of the practice assets. At
June 30, 1997, the Company had intangible assets of approximately $30.4 million
reflected on its balance sheet as long-term affiliation agreements. The Company
amortizes such intangible assets over a 30 year period. See the Notes to the
Company's Financial Statements. The amortization of these intangible assets,
while not affecting the Company's cash flow, has an ongoing negative impact upon
the Company's earnings. During the six month period ended June 30, 1997,
amortization of intangible assets contributed $777,036 to the Company's net loss
of $2.5 million. See "Managements' Discussion and Analysis of Financial
Condition and Results of Operations."
Competition
The business of providing healthcare related services is highly
competitive. Many companies, including professionally managed physician practice
management companies like the Company, have been organized to pursue the
acquisition of medical clinics, manage such clinics, employ clinic physicians or
provide services to IPAs. Large hospitals, other multi-speciality clinics and
other healthcare companies, HMOs and insurance companies are also involved in
activities similar to those of PQC. Some of these competitors have longer
operating histories and significantly greater resources than PQC. There can be
no assurance that PQC will be able to compete effectively, that additional
competitors will not enter the market, or that such competition will not make it
more difficult to acquire the assets of multi-speciality clinics on terms
beneficial to PQC. See "Business - Competition."
Forward-Looking Statements
Certain statements made in this Prospectus are forward-looking,
including without limitation statements with respect to the future affiliations,
capital requirements, future plans for expansion and future success of the
Company, and future development of the healthcare industry. Forward-looking
statements made herein are not guarantees of future performance and are subject
to risks and uncertainties, including without limitation the factors discussed
in this "Risk Factors" section, that could cause actual results to differ
materially from those described in the forward-looking statements.
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